While questions over America’s persistently high current account deficit remain, Trump’s economic revival plan misdiagnoses the problem and wrongly ignores global market logic.
Global markets will acutely worry about the suicidal economics advocated by US presidential candidate Donald Trump during the first round of televised debates. Markets will remain on edge because surveys indicate a close fight between Trump and Clinton. There is bound to be more nervousness closer to the elections.
If some of Trump’s ideas were to be implemented, the world would undoubtedly slip into a new phase of recession. He threatened to act against US companies that leave America to set up operations in cheaper locations like Mexico and China. He said NAFTA was the worst trade deal America had signed and therefore he would not allow American companies shifting operations to Mexico to export goods back to the US.
Trump also made a blanket charge that the US was getting ripped off by most other world economies and asserted that America cannot allow its companies and jobs to shift to other countries. In effect, Trump is also blaming multilateral trade institutions because some of the actions he proposes clearly fall foul of existing World Trade Organisation (WTO) rules.
Trump has particularly targeted China for “manipulating its currency” to build a massive trade surplus with the US. He said Americans were simply importing more consumption goods and running a high current account deficit, thus helping other economies like China. Earlier, he spoke about raising import tariffs to as high as 45% on many items imported from China into the US. A Hong Kong-based economist has estimated that China could lose up to 3 percentage points of its GDP if the US were to sharply raise import tariffs on Chinese products.
And if China’s GDP were to fall so drastically, one can well imagine the havoc it would wreak on other major economies, including India. China still contributes to about 35% of global GDP. In short, Trump’s recipe for US economic revival is based on an unabashedly isolationist trade and economic regime, secured behind high tariff walls. He claims by doing so he would bring US companies and some 25 million jobs back to America. Only problem is most of these US companies operating in emerging economies like China and India do not quite subscribe to Trump’s vision and in fact are fully backing Democratic presidential candidate Hillary Clinton. They know fully well that competitively distributed supply chains across different countries cannot be reversed overnight by the quixotic ideas of Trump. They are not even impressed by Trump’s promise of a dramatic cut in corporate tax rates. They clearly prefer Clinton’s more nuanced approach to global trade deals.
Trump is whipping up paranoia about “America turning into a third world economy” and cites the US trade deficit figure of $800 billion annually to argue that the world is dumping goods in America, which runs a deficit with every country. All this is happening because of the bad trade deals signed by the US government, he says. Trump also accuses the US government of accumulating a debt of $20 trillion with virtually nothing to show for it.
Of course, in this ongoing Trump tirade, what is not stated or admitted is that for years Americans have been fuelling their excess consumption simply by borrowing from abroad, mainly China. At the height of the global economic boom in 2006, about 48% of all American treasury bills were owned by foreigners and a substantial portion of this is held even today by China. In a way, China has been selling goods to America and even financing it at a low cost. It is a bit like vendor financing where the seller of the goods also organises financing for you at low cost.
This American consumer behaviour was characterised by well known economist Stephen Roach as follows,”The excesses of bubble-dependent American consumers provided high-octane fuel for China’s export machine. As export-led Chinese growth surged so did its savings surplus. China recycled that surplus back to the US in order to keep America’s consumption bonanza alive… China, the lender, was a perfect match for America, the debtor.”
This party had to come to an end and the music stopped when the 2008 global financial crises hit America and the rest of the world. The recession that followed was a wake up call for the US to move away from a consumption-led economy to a more savings and investment-led one. Conversely, China, its largest trading partner resolved to fuel its economic growth based more on internal consumption by paring its savings rate (China was saving over 40% of its GDP). America’s high consumption and China’s high savings needed some re-balancing.
At the height of the US debt ceiling crisis in 2013, Roach said , “Tough questions face America. Without China as a buyer of US treasuries [bonds], who will step up to fill the void, and on what terms?”. Roach may have been prophetic because this week Bloomberg released a disturbing news report that the biggest buyers of US treasuries – central banks of China and Japan – are selling like never before. China has been consistently selling US government bonds for the last few quarters from its $3 trillion plus kitty of forex reserves, possibly to fund other physical assets, partly in infrastructure projects across Asia. China is now looking to have greater diversification of its forex reserves into non-dollar assets. If this process continues apace, and China sells US government bonds in its reserves, the US will see higher interest rates going forward. This would cause a fresh round of financial markets uncertainty around the world. It will be another big challenge for the US Fed Reserve.
Clearly, there is a complex background to America’s persistently high current account deficit (CAD). Donald Trump’s economic revival plan seems to ignore the fact that America has consciously abandoned low technology manufacturing because it doesn’t have competitive advantage anymore in making steel, textiles, automobiles etc. Global market logic dictates that the US economy rely more on high technology and innovation led value added growth and leave low-cost manufacturing to companies in the developing world. Consequently, the US imports most of these goods; resulting in a high CAD. Trump wrongly blames America’s rising CAD on unfair trade deals with the other economies.
The real reason for the high CAD has been the massive import-led consumption in the US of most labour intensive manufactures and the near zero savings by the Americans in recent times. One must remember the US consciously admitted China in the WTO at the turn of this century. America’s CAD peaked at over 6% of GDP in 2006 but it came down to about 3% of GDP after the 2008 recession, giving some hope of a structural re-balance. However, that trend is now somewhat reversed as the CAD is going up again, indicating that no sustained savings and investment led growth is happening in the US economy.